Research director at the Socio-Economic & Educational Business Institute (SEEBI)
The government and Bank Indonesia (BI) have agreed to share the fiscal burden of mitigating the impacts of the COVID-19 pandemic and financing the economic recovery. BI will bear the interest cost of Rp 397.56 trillion (US$27.41 billion) in debt for financing public goods, which will be financed by the private placement of government securities (SBN) with the interest cost under the seven-day reverse repo rate.
For non-public goods expenditures for supporting private business and MSMEs, which will be financed with Rp 123.46 trillion in bonds, BI will bear the interest costs of the difference between market rates of up to 1 percent below the seven-day reverse repo rate. But the government will bear by itself Rp 328.87 trillion in bonds for stimulus spending on other non-public goods.
The burden sharing between the fiscal and monetary authorities is considered necessary as the government will have to issue more bonds this year to finance the budget deficit, which is estimated to reach 6.3 percent of gross domestic product. Government debts are predicted to increase to 35 percent this year but still lower than the 60 percent ceiling.
Controlling debt service expenses will reduce the widening primary balance deficit as the fiscal deficit should be brought down again to a maximum 3 percent of GDP starting in 2023, as required by Law No. 2/2020.
Curbing interest expenditures will help maintain market confidence in the country’s macroeconomic management and the sovereign risk rating because the rating will be downgraded if the debt interest spending is bigger than tax receipts.
This is not the first time BI has assisted the fiscal authority. For example, BI stopped issuing Bank Indonesia certificates with a three-month tenor in November 2010 as the government also issued three-month treasury bills to meet its short-term cash needs.
Most central banks around the world also contributed to the financing of fiscal deficits that rose sharply after the pandemic.
Nonetheless, we should be cautious about the direct support of BI in the burden-sharing scheme. Even buying government bonds in the primary market, as BI has done since May, is basically printing money. As of June, the total amount of government bonds bought by BI in the primary and secondary markets already totaled Rp 447 trillion.
When BI needs to rebalance its portfolio, the central bank will have to sell its bond holdings. But releasing large sums of bonds in the shallow domestic financial market may require BI to offer special discounts, thereby affecting its balance sheet. Big sales of bonds also will raise inflationary pressures, thereby affecting the rupiah exchange rate. This in turn will hurt the credibility of its political independence.
The same story also applies to interest payments. The interest expense to be borne by BI may be so large that the expenditures may exceed its surplus. Last year, BI booked a Rp 30 trillion surplus. If this deficit continues for several years, BI equity capital will be eroded. The question though is on whether the government will be able to put up additional equity capital to BI as this institution is not a state-owned company.
Even though the burden sharing is effective for the 2020 state budget, BI should prepare an exit strategy so as not to shock the financial market.
The writer is professor of economics at Faculty of Economics, Jakarta State University and research director at the Socio-Economic & Educational Business Institute (SEEBI) Jakarta.
Disclaimer: The opinions expressed in this article are those of the author and do not reflect the official stance of The Jakarta Post.